79. Operating Exposure. Операционная экспозиция.

Operating Exposure – measures a change in the present value of a firm resulting from any change in future expected operating cash flows caused by unexpected changes in exchange rates.

A firm has economic exposure (also known as operating exposure) to the degree that its market value is influenced by unexpected exchange rate fluctuations. Such exchange rate adjustments can severely affect the firm's position with regards to its competitors, the firm's future cash flows, and ultimately the firm's value. Economic exposure can affect the present value of future cash flows. Any transaction that exposes the firm to foreign exchange risk also exposes the firm economically, but economic exposure can be caused by other business activities and investments which may not be mere international transactions, such as future cash flows from fixed assets. A shift in exchange rates that influences the demand for a good in some country would also be an economic exposure for a firm that sells that good.

Estimating Operating Exposure: 1) Audits/Scenario Analysis: Qualitative examination of the separate elements of a firm’s operating cash flow and anticipating its sensitivity to real exchange rate changes. 2) Statistical Approach: Regress changes in firm value on changes in exchange rates to obtain a quantitative assessment of sensitivity.

Managing Operating Exposure:

Use of Marketing Strategies: a) Market Selection; b) Pricing Strategy/Product Strategy; c) Promotional Strategy.

Use of Production Management: a) Input mix; b) Plant Location & Shifting production among plants; c) Raising Productivity (i.e. lowering costs).

Financial Hedging techniques may also be used

79. Securitization: creation of ABSs, participants and functions, securitization’s impact and risks, regulators’ concerns. Секюритизация: создание ценных бумаг с покрытием активами. Влияние и риски секюритизации, проблемы регулирования.

Securitization is practice of pooling various types of contractual debt such as residential mortgages, commercial mortgages, auto loans or credit card debt obligations and selling consolidated debt as bonds, pass-through securities, or collateralized mortgage obligation (CMOs), to various investors. The principal and interest on the debt, underlying the security, is paid back to the various investors regularly. Securities backed by mortgage receivables are called mortgage-backed securities (MBS), while those backed by other types of receivables are asset-backed securities (ABS).

The process of securitization is complicated. The basics are:

1. Mortgage loans are purchased from banks and other lenders, and possibly assigned to a special purpose vehicle (SPV)
2. The purchaser or assignee assembles these loans into collections, or "pools"
3. The purchaser or assignee securitizes the pools by issuing mortgage-backed securities

Major Participants: commercial banks => sell debt to investment banks, inv. bank => repackage debt into “pools” and sell as individual securities with multiple tranches, investors => 3^rd parties who want to hedge or speculate (mutual funds, trusts, individuals, hedge funds, etc.), insurance companies => provide insurance in case of default (CDS), rating agencies => evaluate credit ratings for each security and even tranche on the risk of default basis.

Advantages of asset-backed securitization for issuers:

1. Gives liquidity: illiquid and hard to sell fin. assets becomes part of an attractive => sellable security => more liquidity.

2. Optimization of asset/liability management: securitization produces matched funding (amount & terms of active assets = amount and terms of passive assets).

3. Reducing credit risk: originator diversify the pool with multiple different securities.

4. More hedging and speculating opportunities and instruments for investors.

Individual securities are split into tranches. Each tranche has a different level of credit protection or risk exposure: there is a senior (“A”) class of securities and one or more junior subordinated (“B,” “C,” etc.) classes that function as protective layers for the “A” class. The senior classes have first claim on the cash that the SPV receives, and the more junior classes only start receiving repayment after the more senior classes have repaid.

Risks: Currency/interest rate fluctuations, Default risk (borrower’s inability to meet interest payment obligations on time), Moral hazard (if the manager earns fees based on performance, he may sell overvalued securities knowing about it); Servicer risk (the transfer of payments may be delayed or reduced if the servicer becomes insolvent).

Critics have suggested that complexity inherent in securitization can limit investors' ability to monitor risk, and that competitive securitization markets with multiple securitizers may be affected by sharp declines in underwriting standards. Private, competitive mortgage securitization is believed to have played an important role in the U.S. subprime mortgage crisis. Off-balance sheet treatment for securitizations coupled with guarantees from the issuer can hide the extent of leverage of the securitizing firm, thereby facilitating risky capital structures and leading to an undervaluing of credit risk. Off-balance sheet securitizations are believed to have played a large role in the high leverage level of U.S. financial institutions before the fin. crisis.

Unlike general corporate debt, the credit quality of securitised debt is non-stationary due to changes in volatility that are time- and structure-dependent. If the transaction is properly structured and the pool performs as expected, the credit risk of all tranches of structured debt improves; if improperly structured, the affected tranches may experience dramatic credit deterioration and loss.